Building a resilient investment portfolio requires you to think beyond stocks and bonds to non-correlated alternative assets. Choosing alternative investments such as hard money loans, mortgage funds, private equity, and others depends on a number of factors, including your risk tolerance, financial goals, current market conditions, and more. Understanding the pros and cons of private equity investment is critical for determining whether it’s the right asset class for you.
Pros of Private Equity Investments
There are several reasons to consider investing in private equity if it feels like a good fit for you and your portfolio.
Profit Potential
Private equity investments have the potential for significant profit. Investing in a fledgling or distressed business that grows and succeeds can result in a big upside. While individual returns will vary, many sponsors have proven to be solid performers.
Flexibility
The private sector has many more investment opportunities than the public sector. You can choose to invest in the industries and businesses that best suit your personal preferences, areas of interest, experience, and risk profile.
Resilience
Like any type of investment, alternative private equity has its ups and downs. For example, when a global pandemic or interest rates affect performance, private equity investors may find unique opportunities with distressed businesses or the opportunity to pivot to high-growth sectors.
Portfolio Diversification
Adding different types of non-correlated asset classes to your portfolio helps stabilize returns and keep you profitable through various types of market conditions. Private equity has a low correlation to public markets, making it a good option for diversification.
Minimal Effort
Investing in a private equity fund gives you the benefits of investing in private equity but lets you delegate the work to professionals to generate passive income. You can also pool your capital with others to get preferential fees or terms. You rely on the investment firm to do the work of restructuring, underwriting, performing due diligence, or executing the defined strategy and reap the benefits if they are successful. This “if” is one of the reasons to consider the possible disadvantages of this particular asset class.
Cons of Private Equity Investments
There are some potential downsides to be aware of as you consider investing in private equity.
High Risk
Your investment depends on the success or failure of a business or a portfolio of businesses, and this depends on the skills and experience of the people managing the businesses and the choices the private equity firm makes. Timing the purchase and sale and making the right strategic moves play a major role. The reality is that some businesses fail. If a business you invested in doesn’t make it, you lose your investment.
High Barrier to Entry
In many cases, you need a significant amount of capital to invest in private equity. If you don’t already have some wealth, your options for entering this sector may be limited. One point of entry is through a private equity fund, but this has the drawback of diluting potential returns and likely has higher fees.
Loss Potential
Like any other type of investment, there’s no guarantee that you will make a profit or even get your investment back at all. The key is finding a sponsor and investment vehicle with a strong track record of success that also aligns with your investment interests and risk tolerance.
Lack of Transparency
Public markets are subject to reporting requirements that give you greater visibility into financials. Private businesses don’t have to do this, so you might not have all of the information you want or need to make informed decisions about risk. Ask the sponsor for third-party audited financials.
Minimal Control
Although you don’t have to do the work to improve a business, as an investor, unless you’re in a position to take a hands-on approach, you also have little control over the strategy and implementation. This requires a significant amount of trust in the private equity firm.
Carefully Weigh Your Options
Understanding the pros and cons of private equity investments will help you determine whether they’re the right fit for you. It’s also important to consider your preferences. How much risk are you willing to take on? How hands-on do you want to be? Have you found a firm you trust?
Only you can answer these questions. To learn more about all of your investment options, including private equity, read our Guide to Building a Resilient Portfolio.
